The details are still to be hammered out, but it seems already a nailed-on certainty that one of the consequences of the coronavirus pandemic will be a big expansion of the state into the economy, both in the U.S. and farther afield.
That ought to limit the short-term impact of the virus, which will be severe. How severe, exactly? St. Louis Federal Reserve President James Bullard, for one, said on Sunday that U.S. economic output could halve in the second quarter and send unemployment soaring.
But should policymakers and central bankers the world over throw the kitchen sink at the problem—think unlimited bond-buying, rate cuts, government financed wage supports, tax holidays, and cash handouts—such moves would raise uncomfortable questions about how the rich world digs itself out of the current hole in the longer term.
Until then, here are the most hotly discussed (and debated) options on the table.
Bailouts
In the last week alone, President Trump has flagged aid to the stricken airline industry, while White House economic adviser Larry Kudlow, who 12 years ago was fulminating against the bailout of General Motors, admitted that government equity injections are on the table this time around too.
In France, where President Emmanuel Macron has promised that no company will go bankrupt because of the virus, Finance Minister Bruno Le Maire has talked openly of nationalizing companies, while Germany has earmarked 100 billion euros of a 1-trillion-euro ($1.07 trillion) bundle of measures for equity investments in struggling firms. The U.K. is also considering injecting equity into three big airline groups, according to the Financial Times.
Equity injections for the airlines, who are currently bleeding $10 billion a month, inevitably gain most attention and generate the most political heat. Some accuse Boeing and the airlines as repeating Wall Street’s mistakes ahead of the 2008 crisis, taking too much cash out of a cyclical industry during the boom, leaving it with too few reserves to handle a downturn.
“I don’t think government bailouts of overleveraged companies that got overleveraged via share buybacks at all-time highs, enriching executives and hedge fund investors, will sit well with the American people,” bond guru Jeffrey Gundlach of DoubleLine Capital said via Twitter last week.
However, Steven Blitz, chief U.S. economist with TS Lombard, thinks such an analysis is oversimplistic.
“Debt is a much cheaper form of capital, so it makes sense [for companies] to do that,” Blitz told Fortune. Moreover, he said, critics need to accept that the pressure for such balance sheet acrobatics comes from all kinds of shareholders, including both public and private pension funds. “The economy is not generating the return on equity that investors need to meet their own liabilities…so to make it purely a moral hazard story is unfair.”
Strategic reserves
But the coming flood of bailouts goes well beyond a handful of airlines, and it takes many shapes. Already, last week the government put a supportive hand under an oil and gas industry hit hard by the collapse in demand for fuel, promising to buy 77 million barrels of oil for the Strategic Petroleum Reserve that otherwise could hardly be given away.
At a cost of just over $2 billion, that measure is small beer. On Sunday evening in Washington, D.C., Congress was still arguing over a stimulus package drafted by Senate Republicans with a sticker price of well over $1 trillion, which comes on top of a $500 billion package passed into law last week.
Direct equity injections?
In most cases, the equity injections are a last line of defense. In Europe at least, the first line is government guarantees of corporate debt, coupled with regulatory measures to ensure that banks don’t cut off lines of credit to stressed companies. A new German budget draft this week will include federal guarantees for over 550 billion euros—over one-third of all German banks’ lending to business.
Guarantees have a minimal cash impact on government finances if the credit quality holds, something that should be possible if—as many hope—the economy rebounds quickly when the virus recedes. The same is true of relaxing accounting rules such as the U.S. and China have done.
Tax relief and wage support
Things get more expensive when, for example, government waives tax deadlines, as the U.S., France, and the U.K. have all done. And they get more expensive still when government intervenes to support lost income for workers or to stop companies from laying staff off as their business dries up. The U.K. government said on Friday it will cover up to 80% of furloughed workers’ pay up to a maximum of 2,500 pounds ($2,900 a month)—a measure that could cost up to 3.5 billion pounds a month for every 1 million workers. For context, Germany’s Labor Ministry expects 2.15 million people to tap an existing facility for wage subsidies, according to various reports. Capitol Hill is still fighting over how far the U.S. should go in that direction.
Senate Republicans will do their best to keep an American plan free of direct wage supports, as the Europeans are plotting. And yet the U.S. and European approaches are beginning to look more similar by the day.
Buying bonds and corporate debt
The Federal Reserve’s latest unlimited quantitative easing program, unveiled on Monday, will see it buy $500 billion of Treasuries and $200 billion of agency commercial mortgage-backed securities, a huge boost for credit-strapped companies and municipalities. It follows a similar blueprint laid down by the European Central Bank’s 750 billion euro QE program, which is very business friendly. The Fed is not allowed to “pick winners,” whereas even before the coronavirus, the ECB’s QE program was helping the likes of luxury group LVMH to take over Tiffany & Co. with effectively free money.
The reflex to keep companies afloat—however natural—inevitably stores up trouble for a later day. Paul Donovan, chief economist with UBS Global Wealth Management, noted in a podcast last week that President Macron’s promise effectively keeps alive thousands of businesses that ought to be leaving the market (there were 52,000 insolvencies in France last year). British and German taxpayers looking at Royal Bank of Scotland and Commerzbank today may well wonder whether their money was spent wisely bailing the two banks out a decade ago.
However, those who dare to mention such risks at present don’t have a chance of success. Austrian central bank governor Robert Holzmann warned last week that such measures nullify the “purifying effects” of a downturn, citing the doctrine of the Austrian school of economics’ leading light Joseph Schumpeter, which holds that the “creative destruction” of recessions improves an economy’s long-term health. The ECB not only issued a statement contradicting what he said elsewhere in the interview, it also unfolded its 750 billion euro comfort blanket within 24 hours.
As Mark Schieritz, ECB correspondent for the left-leaning German newspaper Die Zeit, noted tartly, “The Austrian school should remain closed for the duration of this crisis.”
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